Construction Industry Insight (Spring 2016)

This document focuses on a number of topics that affect the construction industry as a whole, including factors that influence the values of new and used construction equipment, the volume of equipment sales, the profitability of equipment manufacturers and the impact of foreign-based companies. It also includes a brief summary of trends in used equipment values.

Hot Topics

Five-Year Highway Bill Signed into Law: In December 2015, both the House of Representatives and the Senate voted overwhelmingly to pass the Fixing America’s Surface Transportation (FAST) Act. This Act, which was quickly signed into law by President Obama, represents the longest reauthorization of federal transportation programs approved by Congress in more than a decade. The five-year legislation is designed to improve the Nation’s surface transportation infrastructure, including our roads, bridges, transit systems, and rail transportation network. The bill reforms and strengthens transportation programs, refocuses on national priorities, provides long-term certainty and more flexibility for states and local governments, streamlines project approval processes, and maintains a strong commitment to safety. Under the Act, funding will increase by approximately 11 percent over five years. The $305 billion in total authorized funding will come from the gas tax and $70 billion in offsets to the federal budget. The Fast Act is expected to provide a substantial boost for construction companies, as well as a major advantage for the heavy equipment industry. Brian McGuire, Associated Equipment Distributors President stated, “Over the next five years, the hundreds of billions of dollars in federal highway and transit investment guaranteed in the bill will stimulate more than $13 billion in equipment sales, rental and maintenance activity, and support more than 4,000 dealership jobs each year.”

Chinese Bid for Terex Elevates U.S. Fears Regarding National Security: In February 2016, Zoomlion Heavy Industry Science and Technology Co. (Zoomlion), China’s second largest manufacturer of construction equipment, confirmed that it had made an offer to purchase the U.S. crane maker, Terex Corp. The unsolicited bid values Terex at approximately $3.3 billion. In response, Terex stated that it continues to recommend an offer struck with Finnish rival Konecranes in August, but is also in continuing talks with Zoomlion. Without agreement from Konecranes, Terex may not terminate its existing agreement unless and until Terex shareholders vote upon, and fail to approve, the Konecranes transaction, or Terex is otherwise entitled to terminate under its agreement with Konecranes. Both Konecranes and Zoomlion believe the transaction would help them better cope with the cooling Chinese and weak European demand for construction equipment. Zoomlion noted that its 2015 net profit would fall by as much as 90 percent due to a slowdown in China. A potential deal with Zoomlion has raised a number of concerns regarding U.S. national security in light of the company’s long-time role as a supplier of the China Peoples Liberation Army, coupled with the fact that Terex provides critical infrastructure equipment to a number of government agencies. Further, Reuters has reported that the deal could be blocked by the Committee on Foreign Investment in the United States (CFIUS). Terex has 97 so-called priority-rated contracts with the U.S. government that could attract CFIUS scrutiny. Although Zoomlion is confident its deal would win regulatory approval, Terex shares have stayed well below Zoomlion’s offer of $31, a price the stock has not seen since November 2014. This is a strong indication that investors do not expect the deal to materialize.

Global Construction Equipment Market Down 16.2%: According to information contained in the annual Yellow Table recently released by European construction publisher KHL, construction manufacturers across the globe have taken a hit this past year. Revenues for the world’s largest construction equipment manufacturers dropped 16.2 percent to $133 billion. These are the lowest revenues reported in the table since 2009, when the industry saw sales fall to $109 billion during the Great Recession. It also represents the sharpest year-over-year decline in revenues since that time. “The most striking impact of this market trend was seen among China’s largest construction equipment manufacturers,” says KHL in a March 28 release. All Chinese companies fell in the rankings compared to a year ago, and Shantui experienced the largest drop, falling seven places to No. 38. Among the table’s top 10, No. 9 XCMG was the only Chinese manufacturer to remain. Caterpillar, at 18.1 percent, and Komatsu, at 10.5 percent, held on to their respective No. 1 and No. 2 positions. As shown in the following table, there was much more movement in the remaining top 10 positions, with Terex displacing Hitachi as No. 3 and Liebherr overtaking Volvo to capture No. 4. KHL points out, however, “there’s not much difference in revenue terms between Terex, Hitachi, Liebherr, Volvo and John Deere, which occupy positions No. 3 through No. 7. It’s fairly common to see them shuffle about like this.”

Construction Equipment Rental Market Expected to Reach $84.6 Billion by 2022: In March 2016, Research and Markets issued a report in which they forecasted that revenue for the construction equipment rental market would reach almost $85 billion by the year 2022. The availability of a more extensive inventory of modern, productive machinery, coupled with the brisk pace of infrastructural development are expected to drive demand. More and more construction companies are realizing that significant cost savings can be achieved by avoiding the stringent regulations, financial constraints and increasing cost of ownership associated with major capital outlays and having to either repair or replace warn or technologically outdated equipment. A considerable shift towards renting over buying due to smaller capital outlays, lower maintenance, improved cost control and reductions in transportation fleets is expected to contribute to the boost in revenue growth over the forecast period. Manufacturers are aggressively focused on providing tailored solutions and financial packages in order to meet the requirements of individual customers, which is further projected to drive revenue growth. The reduced burden of upfront investment, and eliminating the risk of expensive breakdown repairs, are expected to result in lucrative growth opportunities. For instance, over 80% of the machinery sold in the UK goes to the plant hire companies (i.e., companies that hire out specialized machinery to building firms). Finally, substantial growth in the construction equipment rental market is expected to be particularly prominent across countries such as China considering government requirements of state-owned enterprises to operate efficiently from a financial perspective, continued privatization of the industry, increased health and safety regulations and rising labor costs.

Heavy Equipment Volume Declines in 2016 Florida Auctions: February has long been one of the most active months for heavy equipment sales. It typically serves as the kickoff month for heavy equipment auctions and is seen as the barometer of what to expect in the used equipment market over the course of the coming year. A March 2016 article published by EquipmentWatch Intelligence noted a significant overall decline from 2015 to 2016 in the sales volume of the five heavy equipment types most commonly sold at auction. The most popular equipment type was crawler mounted hydraulic excavators, closely followed by four-wheel drive articulated wheel loaders. Other popular equipment types were electric self-propelled scissor lifts, backhoe loaders, and telescoping boom rough terrain lift trucks. The volume of telehandlers and backhoe loaders decreased by 78% and 41%, respectively. During the same period, the volume of electric self-propelled scissor lifts and four-wheel drive articulated wheel loaders increased by15% and 5%, respectively, but not enough to offset the other declines. As a result, the total volume across the five most popular types of equipment fell by 27%, while all heavy equipment volume decreased 16% compared to 2015. Unlike volume, the average age of the top five equipment types was relatively unchanged from the prior year. In 2016, the average age was 10.69 years, representing a decline of less than 1% from the average age of 10.78 years in 2015. The most significant change came from the 4-wheel drive articulated wheel loaders, which experienced an age decline of almost 2 years. Telehandlers and backhoe loaders, equipment types with most significant drop in volume, both gained a year on their average ages, indicating they are either experiencing lower popularity in auctions or are being kept and used for longer periods of time.

In summary, prices in the used equipment market are influenced by both volume and age. As such, it is difficult to single out any one factor to determine its effect on pricing. Greater volume can decrease the price of equipment since it gives buyers more options. At the same time, higher age will also likely decrease the price of equipment as such equipment has less retained value and more wear and tear. This year, prices for earthmoving equipment dropped across the board, which may have more to do with the larger market than with the condition of individual assets.

Trends in Used Equipment Values

A recent survey taken by Thompson Research group shows that equipment values were meaningfully lower during the fourth quarter of 2015. More than have of the auctioneers surveyed indicated that used equipment values were down, while appraisers were evenly split between flat and down. Pricing was particularly weak for oil and gas, and mining specific equipment. Thompson noted that this was the weakest survey result since the beginning of 2010 and cited a number of factors that seem to be driving values lower. Primary among these are reduced oil and gas activity and the impact of a stronger U.S. dollar. The recent strength of the U.S. dollar is having an adverse effect on equipment values as foreign buyers exhibit a lower ‘willingness to pay’. In fact, Ritchie Bros in their year-end press release indicated that for the full-year, only 10% of Gross Auction Proceeds in the United States were generated by international buyers, down from 14% in the prior year. Despite the flat to downward trend in used equipment values, prices generally remain at high-levels. This fact, along with the recent passage of a federal highway bill and the reluctance of contractors to make major capital outlays in an uncertain market bode well for the used equipment industry.